Why you should care

A system of remunerating hotshot lawyers, in place for decades, may be crumbling.

By James Fontanella-Khan, Sujeet Indap and Barney Thompson

The Daily DoseAPR 13 2018

Scott Barshay had just closed out the finest year of his career. The acclaimed corporate lawyer had advised on roughly $300 billion worth of transactions in 2015, most notably Anheuser-Busch InBev’s $103 billion takeover of rival brewer SABMiller. In the process he generated about $100 million in fees for his law firm, Cravath, Swaine & Moore, which ranks among the most prestigious in America.

Just four months later, he quit. Frustrated with Cravath’s age-old system of paying its partners according to longevity and seniority versus sheer output, Barshay left the only firm he had ever worked at to move to a New York rival. Paul, Weiss, Rifkind, Wharton & Garrison agreed to pay him more than $10 million a year, a package worthy of his thick book of business — which includes blue-chip names such as Qualcomm and Kraft Heinz — in the hopes he could turbocharge its dealmaking practice.

For those who stay the course … it is a lifetime career that comes with a guaranteed annual salary of several million dollars.

The decision shook the legal industry. Becoming a partner at a firm like Cravath, with access to the global corridors of power, from business to politics, is considered the pinnacle of the legal industry. The so-called white-shoe firm tried to downplay Barshay’s 2016 move, arguing that its culture and history could weather a one-off departure. But it has turned out not to be an isolated incident. In the past year, two more partners, both younger than Barshay, have left for Kirkland & Ellis, another rival with an aggressive strategy to lure top lawyers with big sums.

Lawyers are hardly poorly paid at Cravath: First-year juniors reportedly start at $180,000 a year, while the equity partners earn an average of about $4 million a year, depending on business flow. But a group of firms is determined to use remuneration as a means to secure the services of superstar lawyers to disrupt rivals who have dominated the industry, in some cases, for centuries. The behavior has created a dynamic where top lawyers are now able to command the kind of annual salaries associated with leading investment bankers, hedge fund managers and even top athletes.

The defections threaten the cradle-to-grave culture at venerable firms, such as Cravath and its peers in the U.S. as well as firms like Slaughter and May in Britain. Behind each of these is a payment system known as the lockstep. The system is intended to guarantee collegiality among partners. For instance, if a takeover specialist has a client who is looking for a lawyer to deal with an antitrust issue, that partner is more likely to recommend a colleague who is better versed in the subject if his or her profits will not be affected.

The antithesis of this approach is a model evocatively branded “eat what you kill”: After sharing certain costs, partners keep most or all of what they have generated themselves. In between the two is the “modified lockstep” — profits are shared partly according to seniority but with some way of rewarding partners who are the best performers and the most valuable to the firm, both financially and reputationally.

“It’s becoming more and more difficult to retain star talent in a purely lockstep model,” says Brad Karp, chairman of Paul, Weiss, which has a modified lockstep. “You’re seeing sums that rival sports free-agent compensation arrangements being offered to star partners at corporate law firms,” he adds. And if lawyers work in a system where older partners make three times as much simply by virtue of having been there longer, why wouldn’t they head to a firm that appreciates their talents?

This is more than an arcane question of how lawyers get paid. Cravath is a small firm by today’s standards but it is still an elite one, whose status has been predicated on skill in complex, high-stakes takeovers and trials. Across the world, firms are trying to figure out how to survive — go global, stay local, be boutique. It is an intensifying battle to see which will be left standing in a mature, low-growth market.

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The origins of lockstep compensation, which several elite law firms have adopted at one time or another over the past two centuries, stem from the Cravath system created by Paul Cravath, who in 1883 represented George Westinghouse against Thomas Edison over the patent for the lightbulb.

Every summer a large group of top law students is hired to support Cravath’s senior partners. Fewer than 10 percent will make the partnership, perhaps after eight or nine years. Working up to 100 hours a week, the junior lawyers rotate across groups and projects to maximize knowledge and versatility. Clients “belong” not to any particular lawyer but to the firm as a whole.

For those who stay the course to become Cravath partners, it is a lifetime career that comes with a guaranteed annual salary of several million dollars. Underscoring the “lifetime” part are traditions such as the Cravath Walk: Every partner is entitled to a procession of past and present partners at their funeral, after which the assembled lawyers chant, “The partner is dead, the firm lives.”

In its 200-year history, Cravath has almost never made “lateral” hires from rival firms. And while some partners would leave for government, to become bankers or a general counsel in Fortune 500 companies, it was until recently practically inconceivable for anyone to voluntarily depart for another law firm.

“The Cravath system is designed to develop our talent organically, ensuring consistently high quality throughout the firm while fostering a collaborative and client-centered culture that enables us to deliver the best advice to our clients,” Cravath said in a statement. “We remain confident that our model is the right one for our business, our people and the clients we serve.”

When Barshay left Cravath in 2016, many at the law firm argued that losing their top dealmaker was a sacrifice worth making to protect its sacrosanct culture. Barshay is calm and unflappable but he is also ultracompetitive; not everyone at Cravath considered him a team player (others, however, argued that he was very collaborative).

But then two more partners followed him out the door: Jonathan Davis, 35, in 2016 and Eric Schiele, 43, this year, both of whom were seen as future pillars of the firm. “These guys were the next generation of leaders, their departure is worse than Barshay leaving,” says a person close to Faiza Saeed, Cravath’s presiding partner.

Like another star junior partner, Sarkis Jebejian, who left Cravath in 2012, Davis and Schiele moved to Kirkland, a Chicago-based firm whose historic strength was in litigation (Kenneth Starr, the special prosecutor in the Bill Clinton–Monica Lewinsky case, was a longtime partner). Kirkland has methodically poached deal lawyer talent in both New York and London by offering rich pay and allowing partners to grow their practice without the constraints of the lockstep pay model.

Kirkland’s firepower became abundantly clear just before Christmas when David Higgins, a top private equity lawyer at Britain’s elite “magic circle” law firm Freshfields Bruckhaus Deringer in London, jumped ship for a reported $10 million a year. For a U.K. lawyer, that is a great deal of money — perhaps four times as much as the best-paid equity partner at a top 10 City firm.

But what really rankled in that case was that Freshfields had overhauled its lockstep model, allowing top fee generators to make as much as five times junior partners, specifically for star performers like Higgins. Yet no sooner was the new system in place than he left. Freshfields could pay Higgins more — but not as much as Kirkland. (He escaped the furor over his defection by disappearing to Bhutan for two weeks.)

As news spread of higher salaries at Kirkland, Latham, Skadden Arps, White & Case and others, the hungrier lawyers in City firms started to ask whether senior partners were pulling their weight. “Younger partners were looking at their older colleagues at the top of the lockstep and questioned how they justified their bigger slice of the equity pie,” says Stephen Rodney, chief executive at legal recruiter Fox Rodney Search. “[U.S. firms] were able to attract people by paying them a lot more money.”

The risk for the big-spending U.S. firms is they burn through dangerous amounts of cash on lawyers. “History is littered with the corpses of law firms that overspent on lateral hires, so there is always a question of sustainability,” says Steve Cooke, senior partner at Slaughter and May, the U.K. firm closest in ethos to Cravath. “It’s very hard to hire multiple stars from the outside without damaging the internal ecosystem, if of course the firm has a good one in the first place.” Last year, Slaughter and May hired a pensions expert from Herbert Smith Freehills; it was the firm’s first hire at partner level in 128 years.

The ghost at this particular feast is the defunct U.S. firm Dewey & LeBoeuf. After several years of rapid expansion, the firm went bankrupt in 2012, torpedoed by lavish contracts for top rainmakers when clients were cutting back on legal work after the 2008 financial crisis.

The likes of Cravath, Debevoise, Cleary Gottlieb Steen & Hamilton, Wachtell and Slaughter and May are determined to maintain the lockstep model but recognize it requires conviction. “Lockstep is not easy. It’s an affirmative choice that requires a shared sense of purpose,” says Michael Gerstenzang, the partner leading Cleary.

“For lockstep to work you need three things: First, it must be really hard to make partner; second, partners who are not producing need to go; and third, everyone needs to be making enough money,” says an M&A banker who used to work at one of the lockstep firms.

Lockstep firms also like to tell horror stories about life at hard-charging, eat-what-you-kill firms where partners vie with each other for clients. Instead of producing up to 1,800 billable hours of work a year (work a lawyer can charge for), some are said to demand as much as 2,500 billable hours. “There is a perception of pure lockstep that it is a kinder environment, but sometimes there is a huge amount of pressure — you’re either in or you’re out,” says Rodney. “In merit-based firms it is true you can be brought down — but at least you can be brought up again.”

There is no doubt that working for the elite London and New York firms still has enormous cachet. According to Jeffrey Lowe, global practice head at the legal recruiters Major, Lindsey & Africa, defections may continue but such prestigious firms will retain their advantage.

“At a Cravath or a Sullivan & Cromwell, for example, you will always be perceived to be at the top of the food chain. There will always be people at the top of the food chain who could make more money somewhere else. But a lot of people don’t measure themselves in dollars — it’s about where you went to school, where you summer, what firm you work at. It’s all part of a persona.”

Still, Cravath understands the world is changing. Multiple sources close to the firm say it is considering having partners rotate among clients so no single attorney “owns” the relationship. It has also convened a committee to examine its compensation system, launched a social media strategy and made other changes to ensure its appeal to a new generation of young, ambitious lawyers.